Economics Law Project The project requirements are intentionally flexible to permit you to choose an interesting topic and present it in an interesting man

Economics Law Project The project requirements are intentionally flexible to permit you to choose an interesting topic and present it in an interesting manor. My grading will accommodate different approaches to satisfying the project requirement. Thoughtful application of mechanism design to law is the main requirement.Just follow the guidelines, and I upload several materials that it should write or conclude. Law  and  Economics    
Professor  Joseph  Daniel    
Final  Project  Guidelines    
 
The   essence   of   this   project   is   for   you   to   choose   a   legal   topic   that   is   of   interest   to   you   and  
demonstrate   that   you   can   apply   economic   analysis   to   the   legal   issues   raised   by   the   topic.  
One  approach  to  identifying  a  topic  is  to  skim  the  National  Law  Journal  or  legal  sections  of  
The   Econcomist,   New   York   Times,   Washington   Post,   Wall   Street   Journal,   Philadelphia  
Enquirer,   or   similar   source   for   actual   cases   or   other   legal   disputes   that   are   in   the   news.  
Another  approach  is  to  think  of  an  application  of  a  mechanism  that  we  study  in  the  course.  
It  is  best  if  you  limit  your  topic  to  the  areas  of  property,  contracts,  torts,  crime,  or  concepts  
of  justice.  You  may  not  do  project  on  antitrust  law  and  economics.    
You   should   list   sources   that   you   used   for   the   project,   but   you   do   not   have   to   use   outside  
sources.  
Some  very  good  projects  have  been  based  entirely  on  the  student’s  own  ideas,  without  any  
external  references.    
Most  acceptable  papers  are  in  the  rage  of  8  to  12  pages.  Shorter  papers  usually  indicate  lack  
of   effort.   Some   papers   have   been   30-­?40   pages.   That   is   unnecessarily   long,   but   I   do   not  
impose  a  limit.    
Your  project  should  include  graphical  models  where  appropriate.  You  should  compose  the  
project   as   if   you   are   addressing   someone   with   the   background   of   your   classmates.   The  
project  is  due  on  the  day  that  the    
University  schedules  the  final  exam  for  this  course.  The  project  is  in  place  of  a   final  exam.  
There  is  no  final  exam.  
The   project   requirements   are   intentionally   flexible   to   permit   you   to   choose   an   interesting  
topic   and   present   it   in   an   interesting   manor.   My   grading   will   accommodate   different  
approaches   to   satisfying   the   project   requirement.   Thoughtful   application   of   mechanism  
design  to  law  is  the  main  requirement.    
Creativity  is    rewarded.  
 
It is impossible to travel anywhere or to travel for long in that confusing forest of learned judgments
which constitutes the Common Law of England without encountering the Reasonable Man. He is at
every turn, an ever-present help in time of trouble, and his apparitions mark the road to equity and
right. There has never been a problem, however difficult, which His Majesty’s judges have not in the
end been able to resolve by asking themselves the simple question, ‘Was this or was it not the conduct
of a reasonable man?’ and leaving that question to be answered by the jury.
This noble creature stands in singular contrast to his kinsman the Economic Man, whose every action
is prompted by the single spur of selfish advantage and directed to the single end of monetary gain.
The Reasonable Man is always thinking of others; prudence is his guide, and ‘Safety First’, if I may
borrow a contemporary catchword, is his rule of life. All solid virtues are his, save only that peculiar
quality by which the affection of other men is won. For it will not be pretended that socially he is
much less objectionable than the Economic Man. From A. P. Herbert’s fictional case, Fardell v. Potts –
originally published in Punch magazine in 1924.
Lecture 1
Introduction
1.1 Rationality and Reasonableness
The fundamental problem in law and economics is how to encourage an
economically rational man to behave as a legally reasonable man. Rational people
systematically pursue their self-determined objectives, subject to economic and legal
constraints that their environments impose on them. They frequently behave
opportunistically, meaning that they take advantage of opportunities to further their
own objectives even when their actions potentially impose large losses on others.
Legally reasonable people, on the other hand, act with due regard for others, and weigh
the personal benefits of their actions against the costs they impose on others. While
they pursue their own objectives, they refrain from opportunistic behavior when their
gains are small relative to other people’s losses. Law is the social contract by which
1.2
J. I. Daniel, Mechanisms in Law and Economics © 2018
rational people give up the freedom to do whatever they want in exchange for a social
agreement to behave reasonably. Whenever people behave reasonably rather than
opportunistically, the net welfare of society improves.
There are many ways in which the law encourages rational people to behave
reasonably. Property law forbids unreasonable interferences with other peoples’
enjoyment of their property, and uses the power of the state to defend these rights.
Contract doctrines promote mutually beneficial exchanges by requiring rational people
to fulfill their commitments so that others can rely on their performance. Tort law
establishes reasonable standards of care that people have a duty to observe when acting
in ways that may potentially harm others. Criminal law punishes people for egregious
violations of the physical integrity or property rights of others in a way that that
threatens the peace and security of society.
The central concern of mechanism design is how to create a system of incentives,
communication, and behavior so that individuals who pursue their private goals and
make decentralized choices can achieve socially desirable outcomes in equilibrium from
which no one wishes to deviate. The reasonableness of social goals has various
mathematical specifications, such as maximizing the joint surplus of property owners
with incompatible land uses, minimizing the social cost of accidents, maximizing joint
profits from contracts with reliance expenditures (contract specific investments), or
minimizing the enforcement, punishment, and victimization costs associated with crime.
Social objectives can also include mathematical formulations of fairness or justice.1
Rationality is the systematic pursuit of private goals, usually utility or profit
maximization, subject to budgetary, technological, and legal constraints. Mechanism
design specifies an exchange of information and strategic actions together with a set of
rules that modify the agents’ payoffs using liability, compensation, and/or penalties, so
that their rational strategies align in equilibrium with reasonable behavior.
The economic environment for mechanism design has the following elements:
•
•
•
A social objective is some well-defined concept of the social good, e.g., profit
maximization, consumer or producer surplus maximization, fairness, or
Rawlsian justice. The social objective is exogenous to the mechanism.
The agents are a group of decision makers who pursue their own individual
objectives while interacting with others.
The agent types specify their individual characteristics, which may or may not be
observable by others. The types usually include the agent preferences, and may
1 One such formulation of “fairness” is that no agent prefers another’s consumption level that is affordable
at a level of work effort that the agent is willing and able to provide, given his level of skill. The Rawlsian
concept of “justice” is to maximize the well being of the least well off member of society.
Introduction
•
•
•
•
•
•
1.3
also include income, costs, benefits, skill, and other heterogeneous
characteristics. A type profile is an n-tuple of the realized types that are drawn
from each agent’s type space.
The state of nature refers to exogenously determined conditions of the
environment that may occur randomly according to a probability distribution.
An information structure specifies what agents know about each other’s types
and the states of nature. Information may change as agents interact, learn, and
events unfold.
An equilibrium concept is an explicit statement of the conditions that the agents’
strategies must satisfy to be considered a stable outcome, in the sense that
agents cannot improve their individual objectives by deviating from their
equilibrium strategies. The most common equilibrium concepts are dominantstrategy, Nash, sub-game perfect, and Bayesian equilibria.
Implementation of the social objective using an equilibrium concept requires
that the set of socially optimal outcomes is the same as the set of equilibrium
outcomes, for all possible combinations (realizations) of agent types. This is a
demanding requirement that enforces a mathematically rigorous relationship
between decentralized private behavior and the attainment of social objectives.
The mechanism consists of
a) an exchange of information and strategic actions (message spaces), and
b) a set of rules (outcome functions) that map the information and
strategies into individual outcomes.
The mechanism is endogenously designed to assure that it implements the social
objective as the result of a specific equilibrium concept.
An authority is an entity that oversees the mechanism and has the ability to
enforce the outcomes that the mechanism associates with the agents’ choices of
messages and strategic actions.2 An authority is distinguishable from a
Pigouvian social planner because it does not typically have information or
expertise except as provided by the agents.
1.2 The development of Law and Economics
Many of the foundational ideas of Law and Economics were originally developed by
such polymaths as Thomas Hobbes, Adam Smith, John Locke, Jeremy Bentham, John
Stuart Mill, Leon Walras, Alfred Marshall, Vilfredo Pareto, and Francis Edgeworth during
The authority may be (inter alia) a self-enforcing institution (e.g., a competitive market) or agreement
(e.g., an international treaty), a set of social norms, an employer, a private institution (e.g., a corporation), a
legislature, an administrative agency that enforces rules, or a court backed by the coercive power of the
state.
2
1.4
J. I. Daniel, Mechanisms in Law and Economics © 2018
a time when there were less clear distinctions between academic disciples than today.
Their contributions are still highly relevant to the field, as you will see in subsequent
chapters. During the 19th century, however, Law and Economics diverged as lawyers
and economists became more specialized and both fields sought to become more
distinct. This separation persisted through the first half of the 20th century, except in the
area of antitrust law and the economics of market power.
During the Great Depression and World War II, as macroeconomists coalesced
around Keynesian theories of monetary and fiscal policy interventions, Arthur Pigou
and his followers developed microeconomic models of policy interventions by social
planners to correct market imperfections. Pigou’s models featured social planners who
were perfectly informed, selfless, and possessed unlimited and costless powers of
enforcement. The Pigouvian approach had three branches that correspond to three
main sources of market failure: market power, externalities, and public goods. This
economic theory justified the dramatic expansion of law to regulate an increasingly
industrialized, urbanized, and integrated economy. The Pigouvian social-planner
approach reached its high water mark in the mid twentieth century.
Market power refers the ability of a producer to its raise price above its marginal cost
of production by a minimum amount (usually 10%) and maintain the price for a certain
period (usually a year) without losing sales. This branch of the Pigouvian approach
justified the social planner’s regulation of natural monopolies or the use of antitrust law
to restore marginal cost pricing. This branch lead to the law and economics of antitrust
and regulation, which developed in parallel with the law and economics of property,
contracts, torts, and crime. Market power and antitrust are usually the subjects of a
separate course on Antitrust Economics. Chapter two contains some material on scale
economies and market power, but this text does not attempt to cover antitrust
economics.
The theory of public goods concerns goods that exhibit the properties of nonrivalry
in consumption and nonexcludability in distribution. One person’s consumption of a
nonrivalrous good does not reduce the amount of it that is available for others to
consume. Distribution of a nonexcludable good makes it equally available to everyone,
whether they pay for it or not. Examples of public goods include parks, roads, broadcast
television and radio, and information and knowledge. These goods are usually
inadequately provided by the private sector because consumers “free ride” by
consuming the amount of the good that others provide, without paying for it
Introduction
1.5
themselves. Pigouvian social planners determine how to finance a public good and how
much to provide.
An externality is the effect of one individual’s consumption or production decisions
on the well being of another individual. Smoking is an example of a negative externality
in consumption. Smokers may enjoy cigarette smoke, but those around them often do
not like second-hand smoke. When smokers light up in a crowded room, they do not
consider the external effect of their smoke on others, resulting in an excessively smokefilled room. There are also positive externalities in consumption (e.g., planting flowers)
and positive and negative externalities in production (e.g., beekeeping or polluting
water). In each case, the decision maker experiences private benefits or costs of an
action that imposes additional costs or benefits on others. Consequently, the privately
optimal activity level does not minimize social costs or maximize social benefits. One
common intervention by a social planner is to impose a Pigouvian tax or subsidy equal
to the external cost or benefit of the activity to society. We will develop specific models
of these market imperfections in subsequent chapters.
By the mid 20th century, the idea of a social planner intervening in a market to
correct inefficiencies associated with public goods or externalities was thoroughly
engrained in economic thinking. At this time, a group of economists and legal scholars
assembled at the University of Chicago was about to revolutionize antitrust law by
reconciling it with economic models of market power. This set the scene for the seminal
event in the reunion of Law and Economics. In 1960, Ronald Coase presented his paper,
“The Problem of Social Cost” to the economics faculty at Chicago. The paper was an
attack on the Pigouvian social planner’s intervention in markets. Interpretations of the
paper have evolved over time, but the following statement of Coase’s “Theorem” has
endured five decades of controversy.
1.3 The Coase “theorem”
1) If the property rights are clearly delineated and the parties are able to
transact (negotiate) costlessly, they will arrive at an efficient outcome
without the social planner’s involvement and regardless of the initial
delineation of property rights, and
2) When positive transaction (negotiation) costs would prevent the
parties from arriving at an efficient outcome, the property rights should
be assigned so that the most efficient outcome will result.
1.6
J. I. Daniel, Mechanisms in Law and Economics © 2018
The Pigouvian Paradigm
The welfare function: f Hq L = h Hs Hq LL
Type q’s problem: arg max Ui Hsi ; qi L -ti Hsi L = s` i Hqi L ti
si
Social Planner’s Problem: arg max h Is? Hq L tM = t? Hs, q L
t
h Is? HqL t? Hs, qLM = max f HqL
Social outcome:
The Coasean Paradigm
q
Judges anticipate the outcome of agents bargaining to individually rational,
joint welfare maximizing outcomes for each rights regime.
`
sr e arg max 8U1 Hs1 ; q1 L wr -t1 r +U2 Hs2 ; q2 L wr -t2 r < s.t. s é Ui Hsi ; qi L wir ? Ui r , i = 1, 2 ` ` ` Ur HqL = U1 r Is?1 r ; q1 M - t1 r + U2 r Is?2 r ; q2 M - t2 r ` Ur=3 ` Judge chooses rights regime r to max Ur ` Ur=1 ` Ur=2 ` Ur=4 reR For those who are already comfortable with economic notation, the summary above shows the formal relationships between the social objective, the Pigouvian social planner or Coasean allocator of rights, and the social outcome. In the Pigouvian Paradigm, the function ????(????) represents society’s preferred outcome, which depends on the realized individual types ????. The social planner recognizes that the agents ???? ? ???? will choose a strategy ????* (????* ) to maximize their own utility ????(????* ; ????* ) given their actual type ????* . The social planner can influence the agents’ choices by imposing an individualized tax ????* (????* ), which depends on their individual strategies ????* . The individuals’ optimal strategies are ????.* (????* )|????* The planner chooses the taxes ????(????), so that the outcome function ?(???? 3(????)|????) is the same as the socially desired outcome ????(????). In the Coasean Paradigm, the rights allocator chooses a regime ???? with rights endowments ????7 , knowing that the agents ???? ? ???? will choose a strategy ????.* (????* )|????*7 to maximize their individual utilities ????* (????* ; ????* ) under each rights endowment ????*7 . The rights allocator calculates the sum of the individual utilities net of transactions costs ????*7 for each rights regime and chooses the regime that results in the maximum sum. Introduction 1.7 We will cover Coase’s paper in detail in a subsequent chapter. For now, lets consider a very simple application of the “Theorems.” Two people are in a room. A gets $1.25 worth of satisfaction from smoking a cigarette. B gets minus $1 worth of satisfaction from second-hand exposure to the smoke from one cigarette. The efficient outcome is to allow smoking because it results in $0.25 worth of net satisfaction. The Pigouvian tax on A would be $1 to smoke. A would pay the social planner $1 and light up. The Pigouvian tax would not be paid to B. Now suppose that there are no transaction costs. If A and B are in a right-to-smoke state, B would only be willing to pay A $1 not to smoke. A would refuse and light up. If they are in a right-to-breath state, A would be willing to pay as much as $1.25 to buy the right to smoke, so B would accept. A would light up. In either case, the efficient outcome prevails. Now suppose that there are transaction costs of $0.50 each to negotiate. If they were in a right-to-smoke state, B would only be willing to pay A $0.50 not to smoke. A would refuse and light up. If they are in a right-to-breath state, A would only be willing to pay $0.75 to buy the right to smoke, so ... Purchase answer to see full attachment